Research and analysis

Looking forward to the future: investigating the proposed acquisition of PacBio by Illumina

Published 13 May 2020

By Eleni Gouliou and Alex Hazell

Introduction

In rapidly developing markets where companies regularly release new and innovative technology, it can be a challenge for competition authorities, such as the CMA, to assess how mergers will affect customers and competition in the market going forwards. Authorities face the daunting task of looking to the likely future evolution of the market and assessing how the development of that market will impact their merger control assessment (and vice versa).

The CMA recently faced these challenges in its merger inquiry into the proposed $1.2 billion acquisition by Illumina, Inc. (Illumina) of Pacific Biosciences of California, Inc. (PacBio). We announced our Provisional Findings^{[footnote 1]} in October 2019, concluding that the merger would be expected to result in a substantial lessening of competition (SLC) and the merging parties later abandoned the transaction.^{[footnote 2] [footnote 3]}

Illumina and PacBio both supply next-generation DNA sequencing (NGS) systems to research institutes, universities and laboratories around the world. DNA sequencing systems are vital to the study of genetic variation in humans and other species, for purposes such as essential disease research and drug development. Our investigation found that the supply of DNA sequencing systems is a dynamic and rapidly growing market, where innovation is key. At present, less than 0.01% of species and less than 0.02% of human genomes have been sequenced, and the merging parties are well-placed to capitalise on this growing demand, with Illumina in particular having approximately 80% share of the worldwide NGS systems market.

A key question underlying our review of this merger was whether Illumina and PacBio compete or whether, as the merging parties submitted, short read sequencing (as supplied by Illumina) and long read sequencing (as supplied by PacBio) are instead used in a complementary way, and are not considered to be good alternatives by customers. While we found that long read sequencing technologies had traditionally been viewed as poor alternatives to short read sequencing technologies by customers (in particular because of their lower accuracy and throughput and higher cost) we also found evidence which demonstrated that the merging parties’ technologies currently compete to some degree and that this competition was likely to increase in future. In particular, we found that PacBio’s recent development and release of a new instrument (known as Sequel II) may have a significant impact on the extent of its competition with Illumina.

The CMA’s investigation had therefore provisionally concluded that the merger would result in an SLC and that the effect of this SLC would be that the merging parties would have less incentive to compete and that this would result in reduced choice for customers, an increase in prices (or a slow-down in the reduction in cost of sequencing), deterioration in quality, deterioration in service provided and/or loss of (or re-focusing of) innovation.^{[footnote 4]}

This analysis summarises the CMA’s learnings from this important case, including the approach taken to the assessment of competition in dynamic markets, sources of evidence used in dynamic markets and the importance of international cooperation.

Nature of competition in dynamic markets

A dynamic context

Competition is a process of rivalry that takes place over time. The evidence we gathered during our investigation, indicated that the market for NGS systems is dynamic, and that innovation is an important factor in how the merging parties compete with one another. Dynamic markets are typically those which are growing and evolving and in which competition revolves around bringing new and innovative products to market.

A dynamic context to a merger may mean that merging parties are particularly focussed on the future evolution of the market and may compete through R&D and releasing new products, as well as through prices. Consideration by the CMA of such non-price factors, in particular, approaches to innovation, is therefore vital in order to adequately protect customers in dynamic markets. In this case, we found that innovation was a crucial aspect of competition and that the merging parties’ common desire to be the preferred sequencer for as many projects as possible, including new projects aimed at customers who may not previously have used sequencing systems, was a key factor driving their innovation efforts and had been for a number of years.^{[footnote 5]}

Our review of mergers means that we must consider what would happen if the merger was allowed to go ahead, and compare this to the situation that would have occurred without the merger. It can, however, be more difficult to predict how a dynamic market will evolve in future. Therefore, the evolving nature of dynamic markets and the need to conduct a forward-looking assessment necessarily requires the CMA to deal with a greater degree of uncertainty than would be expected in more static markets. The CMA applies a ‘balance of probabilities’ standard of proof in phase 2 investigations, and as such, we were careful to remember in this case that the fact that there is uncertainty in how the market will develop should not be interpreted as meaning that the merger is unlikely to give rise to competition concerns and that the standard of proof is not able to be met. The uncertainty often found in dynamic markets such as this one should not mean that the CMA stands by and does nothing when a merger could give rise to harm to customers and competition more generally. Instead, the CMA has to be conscious of that uncertainty but is not bound by it to conclude that harm is unlikely.

The evolution of a highly concentrated market

This case concerned a highly concentrated market with few alternative options for customers, largely due to Illumina’s very strong market presence (approximately 80% of the worldwide NGS systems market and a 90% share in the UK). While Illumina’s strength meant that the increment provided by the acquisition of PacBio was relatively small by comparison (only 10% of the UK market is in the hands of competitors other than Illumina), PacBio was a significant percentage of the remaining market and therefore one of only very few alternative options available to customers.^{[footnote 6]} In highly-concentrated markets with substantial barriers to entry and expansion, the elimination of even a small competitor could remove an important source of competition from the market and have a significant effect on the competitive conditions of that market.

However, evidence of historic direct competition between the merging parties did not necessarily reflect how the market would evolve in future, and how PacBio had influenced Illumina in its innovation strategy to date. We found evidence that the merging parties (and customers) considered that PacBio’s technology developments would mean that it would become a stronger competitor in future, and that Illumina increasingly considered PacBio to be a competitive threat.

Sources of evidence in dynamic markets

Our investigation collated and assessed a large volume of evidence. To reach our conclusions we used our judgement to evaluate the weight that we should place on different pieces of this evidence, considering each piece of evidence in the round and in its relevant context in this case:

• Overall, we placed the most weight on the merging parties’ internal documents which are particularly informative in this dynamic market because they provide context on how the market is developing and how competition takes (and will take) place. Whilst we placed a large amount of weight on internal documents as a whole, we also considered the weight that should be placed on each document according to the circumstances in which the document was produced. Further discussion of the use of internal documents is set out below.

• We placed substantial weight on customer evidence in relation to technical questions that customers, as users, are well placed to answer, such as the uses of the instruments and how they make purchasing decisions. However, we placed more limited weight on customers’ views of the merger itself because in almost all cases, customers saw this as the only option to ensure PacBio’s existence, due to concerns regarding its financial situation.

• We also placed substantial weight on competitors’ internal documents. These internal documents provided evidence on the extent to which they consider the merging parties as competitors and the constraint they perceive between different technologies, while their expansion plans provide evidence of how this might change in the future.

• We placed only limited weight on quantitative evidence in this case, such as the merging parties’ econometric analysis. Traditional forms of quantitative evidence such as this are typically static or historic in nature. Where market developments are occurring at a rapid pace, such as in DNA sequencing, this evidence may be a less informative tool for assessment.^{[footnote 7]}

Internal documents

As the CMA has highlighted previously, internal documents, whether produced by the merging parties or third parties, are an important part of all merger inquiries. However, in dynamic markets such as the market for NGS systems, where past data might not be a good guide to present and future competition, they can be especially useful to get an insight into how companies see current and upcoming changes in their industry.^{[footnote 8]}

Internal documents were particularly useful in this case due to the rapid pace of development of new sequencing instruments. One example was the recent development, commercialisation and launch of PacBio’s new Sequel II instrument. Internal documents were vital to assessing how the merging parties were positioning themselves against each other, and how they envisaged that this would change in the future, particularly following the launch of this new product.

The CMA of course needs to be careful when interpreting merging parties’ internal documents, ensuring not to cherry pick documents, and instead to look at the merging parties’ documents as a whole and in the context of other evidence gathered. The background to and context surrounding those documents (eg the author, intended audience, and purpose for which the document was created) will therefore also be useful in helping the CMA to understand how much weight to give internal documents. This evidence will be particularly persuasive when internal documents from different levels and areas of an organisation (eg, documents prepared by sales, marketing, finance, operations and senior management teams) appear to tell the same story.

Valuation models

The CMA may also scrutinise the price of the target company and consider the models used by the acquirer to value the target. This is particularly important in dynamic markets where the valuation of the target business can also provide some insight into the acquirer’s expectations for the future trajectory of the target (and the extent to which the target presents a competitive threat to the acquirer’s future growth). Although not determinative in this case, work on the valuation model was helpful to understand the high purchase price of $1.2 billion, forecasted areas for future growth, as well as in determining projected future levels of R&D post-merger and comparing these to the situation should the merger have not occurred.

International cooperation

As across all areas of the CMA’s work, international co-ordination and collaboration is key. Due to the parallel investigation by the FTC into Illumina’s acquisition of PacBio, and the global nature of the market in question, this case was one where it was vital to communicate with our international counterparts, to exchange relevant evidence (where enabled via the use of confidentiality waivers), to share best practices through regular calls, and to discuss our respective evidence bases.

This cooperative approach with other competition authorities will likely be of increasing importance to the CMA in the coming years, as we take over jurisdiction for an increasing number of global mergers which are also being reviewed elsewhere.

We have also found that the sharing of evidence and best practices between agencies can be efficient for merging parties, allowing them to leverage work produced for one competition authority, by providing it to another.

What did we learn?

In summary, there are a number of key things that we learnt during this investigation, many of which apply to other recent CMA cases as well as several ongoing investigations which are applying a forward-looking assessment:

1. Where the evidence seen during the CMA’s investigation indicates that the merging parties operate in a dynamic market, it is important to assess such a merger in a dynamic context. In this case, this meant focussing on non-price factors, in particular, innovation.

2. Uncertainty regarding how the market could develop does not mean that a merger is unlikely to give rise to competition concerns and does not mean that a different standard of proof will apply (at phase 2: balance of probabilities).

3. The CMA may still find concerns with a merger when the market share increment provided by the transaction is small. This will be particularly true when there are few alternative options available to customers and when the other merging party accounts for a large proportion of the market.

4. Internal documents of the merging parties and third parties can be a vital source of evidence when conducting forward-looking assessments. The context behind the document, for example the author, intended audience, and the purpose for which the document was created, can help the CMA to determine the evidential weight to ascribe to a document.

5. International cooperation, particularly when markets are global in nature, is hugely useful.

1. Illumina Pacbio: Provisional findings report ↩

2. Illumina press release: Illumina and Pacific Biosciences Announce Termination of Merger Agreement ↩

3. The US Federal Trade Commission (FTC) had also announced their own challenge to Illumina’s acquisition of PacBio in December 2019: FTC Challenges Illumina’s Proposed Acquisition of PacBio ↩

4. Illumina Pacbio: Provisional findings report, paragraph 10.3. ↩

5. Illumina Pacbio: Provisional findings report, paragraph 8.333. ↩

6. Illumina Pacbio: Provisional findings report, paragraphs 8.271. ↩

7. However, we would note that market shares provided a useful background in this case as they have been consistent over a number of years in a dynamic market, and therefore provide insights into the market characteristics and the strength of the players in that market. ↩

8. Illumina Pacbio: Provisional findings report, paragraph 8.122. ↩